When looking for trading opportunities, one place to look is among stocks that have already been strong over the past six months to one year. If a stock has shown strong performance over those time frames, it is typically being accumulated in large quantities. People are interested in that stock, and the greater the price momentum, the easier it is to buy expecting to make 20% to 30% while limiting risk to 5% to 8%. The following stocks are all showing patterns indicating that strength could be returning after a pullback or pause in the strong uptrend.
Morgan Stanley (MS) was very strong in the last half of 2016. The stock pulled back in March 2017, but it has been moving to the upside again since mid-May. The price action since early March resembles a cup and handle pattern, following a strong rally. Traders should watch for a breakout above $46, which is the top of the handle. If the breakout occurs, a stop-loss can be placed at $42.50. If the price breaks higher and then hits that stop-loss, the pattern is not playing out correctly, and it is best to limit losses. In terms of the upside target, traders should consider taking profits on a 20% rally, near $55.20. The stop-loss and target provide for a greater than two-to-one reward-to-risk ratio on the trade. (For more, see: Morgan Stanley Puts Brokers Alongside Bankers in Effort to Boost Business.)
Scientific Games Corporation (SGMS) already had cup and handle patterns play out (between December and January and again between April and June). The most recent cup and handle has two breakout points (on the handle), depending on when the pattern was spotted. The first breakout occurred at $23 after the price broke above a small consolidation. The next breakout occurred at $24. Since these two entry points have already occurred, the profit target is what matters. Since this stock has been more explosive than Morgan Stanley, it is more likely that a 25% profit can be extracted from the pattern. That puts a target at $28.75 to $30. With the price closing at $26.50 on June 20, that still leaves more upside based on the original pattern. Since June 14, the price may be forming another consolidation. A breakout to new highs could signal another long entry, with a stop-loss below the consolidation. If this occurs, it is a good idea to keep the original target area in mind, as this helps assess the risk/reward of the trade.
Everi Holdings Inc. (EVRI) is showing a different type of pattern. It started moving higher in March, and since mid-May, it is moving sideways. Sideways corrections often see a quick move lower before the price moves higher. This doesn't always occur, but it is quite common. Therefore, one option is to buy near $7.26, the point at which the price broke above the sideways correction on July 16. A stop-loss goes below $6.48, and a profit target goes at $9. In this case, the risk/reward is mediocre, and there is a high likelihood that a small pullback stops out the trade. An alternative is to wait for the price to drop below $6.50, triggering all the stop-loss orders that are likely placed down at that level. If the price starts rallying after that, traders could consider buying. This will likely provide a provide better entry, down in the $6.75 region, and if the price keeps dropping, a losing trade is avoided. The risk/reward ratio is also improved because the stop-loss can be placed below the recent swing low, and the same $9 target is used (approximately 25% above the top of the current pattern).
(For more, see: Why Everi Holdings Could Be Positioned for a Surge.)
The Bottom Line
It is a good strategy to watch momentum stocks for new buy signals. Typically, a strong momentum stock will provide several valid and profitable buy signals before the trend eventually reverses. Looking for small cup and handle patterns during a strong uptrend can highlight when a pullback has likely ended and a new rally is starting. Sideways movement after a strong rally can also act as a trade trigger. It is wise to take note of past tendencies in the patterns to help fine-tune timing, as stock prices will often move in the opposite direction just prior to making another strong push in the trending direction. Traders should set the entry, stop-loss and a profit target, and then only take the trade if the risk/reward is favorable. (For related reading, see: The Anatomy of Trading Breakouts.)
Disclosure: The author does not have positions in the stocks mentioned.